Important Disclaimer 2009 Proxy Season Update II: Recent Changes in Delaware Law April 20, 2009 Public companies in the United States are currently in the middle of "proxy season," the period during which many companies hold their annual meeting of stockholders. Last week, our first 2009 Proxy Season Update WSGR Alert reviewed trends in stockholder proposal no-action letters from the Securities and Exchange Commission (SEC), the New York Stock Exchange's (NYSE's) proposed amendments to Rule 452, and the application of advance notice bylaws. In this WSGR Alert, we summarize some significant upcoming changes in Delaware corporate law, several of which may impact not just this year's proxy season but the broader corporate governance debate generally, including issues under consideration at the SEC such as proxy access and mandatory stockholder bylaws. On April 10, 2009, Delaware House Bill #19,1 which amends the Delaware General Corporation Law (DGCL), was signed into law, to become effective August 1, 2009. A summary of the amendments follows. Section 112: Access to Proxy Solicitation Materials The amendments include adding a new Section 112 to the DGCL, which provides that a corporation may adopt (but is not required to adopt) a bylaw that allows individuals nominated by stockholders to be included in the corporation's proxy solicitation materials, including any form of proxy distributed by the corporation. The "proxy access" bylaw may impose "lawful" procedures or conditions on proxy access, such as: - minimum record or beneficial ownership (including ownership of options or other rights), or duration of ownership, by the nominating stockholder;
- receipt of information from the nominating stockholder concerning the stockholder and the stockholder's nominees, including information concerning ownership by such persons of shares of capital stock, options, or other rights;
- limits on the number or proportion of directors that may be nominated by stockholders as well as limits based on whether the stockholder previously sought to nominate individuals;
- prohibitions on nominations by any stockholder if such person, any nominee of such person, or any affiliate or associate of such person or nominee has acquired or publicly proposed to acquire shares constituting a specified percentage of the voting power of the corporation's outstanding voting stock within a specified period before the election of directors; and
- agreements from nominating stockholders to indemnify the corporation in respect of any loss arising as a result of any false or misleading information or statement submitted by the nominating stockholder in connection with a nomination.
There are a number of practical effects of Section 112. Perhaps most significantly, the section permits a "short slate" director election contest on the corporation's own proxy, where stockholders' director nominees are considered for election without the stockholders having to go through the cost and expense of issuing their own proxy statement and solicitation. Proxy access bylaws would, if adopted by corporations, give stockholders unprecedented access to a corporation's proxy materials in director elections, and could make it much easier for dissidents to engage in proxy contests. Consistent with Delaware's enabling corporate-law philosophy of governance, as well as its director-centric model of governance, Section 112 continues to give some discretion to boards of directors to appropriately monitor stockholders' access to the corporate proxy. However, it remains to be seen how these provisions will be interpreted by the courts, particularly since stockholder voting is at stake, given the Delaware courts' strong historic protection of the stockholder franchise. Another important aspect of Section 112 is that it reaffirms the need for boards and their advisers to review the corporate bylaws on all issues relating to stockholder meetings and stockholder actions. There have been several judicial decisions over the last 12 to 18 months, in both Delaware and elsewhere, concerning various procedural and substantive requirements for stockholder meetings and broader stockholder voting issues.2 Partly in response to these decisions, as well as other developments in the capital markets, a number of corporations have amended their bylaws to require, among other things, disclosure of derivative positions held by stockholders seeking to elect directors, disclosure of any potential conflicts by such stockholders, and other information. Section 112 appears to specifically anticipate such bylaws, but it is important to review any such amendments within the context of the purpose for which the bylaws are being adopted, as well as with an understanding of the latest Delaware case law on these issues. It is also unclear how Section 112 will be impacted by the SEC's consideration of the proxy access issue under the proxy rules. Current SEC interpretations of SEC Rule 14a-83 permit a corporation to exclude a stockholder proposal seeking to adopt a proxy access bylaw from the corporation's proxy statement,4 meaning that, unless corporations voluntarily adopt proxy access bylaws, stockholder activists would need to conduct a proxy contest in order to force a corporation to adopt a proxy access bylaw. As discussed in a previous WSGR Alert, SEC Chairman Mary Schapiro recently indicated that the SEC intends to take a fresh look at proxy access, including reconsideration of the proxy access proposals made in 2003 and 2007. There has been some speculation that the Delaware legislature's decision to adopt Section 112 arose, at least in part, to preempt the need for new regulations by the SEC on this issue, and it remains to be seen whether the SEC acts on proxy access in light of the fact that stockholders of corporations incorporated in Delaware now have the ability to obtain proxy access. Section 113: Proxy Expense Reimbursement The amendments also create a new Section 113 to the DGCL, which provides that a corporation may adopt (but is not required to adopt) a bylaw requiring reimbursement from the corporation of expenses incurred by a stockholder in soliciting proxies in connection with an election of directors. Section 113 adopts the holding of CA, Inc. v. AFSCME Employees Pension Plan,5 a recent Delaware Supreme Court case that held that "short slate" reimbursement bylaws were permissible. Like Section 112, a proxy expense reimbursement bylaw may impose "lawful" procedures or conditions on reimbursement, such as: - limits on the number or proportion of persons nominated by the stockholder seeking reimbursement;
- limits on reimbursement if a stockholder previously sought reimbursement for similar expenses;
- limits on the amount of reimbursement based upon the proportion of votes cast in favor of one or more of the persons nominated by the stockholder seeking reimbursement, or upon the amount spent by the corporation in soliciting proxies in connection with the election; or
- limits on reimbursement in elections of directors by cumulative voting pursuant to DGCL Section 214.
One limitation a corporation should consider when adopting a proxy expense reimbursement bylaw is a "fiduciary out" provision whereby directors reserve full power to discharge their fiduciary duties in connection with proxy expense reimbursement requests. The fiduciary out concept was endorsed in a footnote in the CA decision, but was not addressed in the adopting legislation for Section 113. Proxy expense bylaws could, if adopted by corporations, considerably reduce the economic costs to activist investors of proxy contests for director elections. As with Section 112, this section seems to have been adopted, at least in part, to counter the image that Delaware's corporate code is "anti-investor," as well as to possibly preempt action by the SEC in an area traditionally considered to be under the purview of state corporate law. In addition, as with Section 112, Section 113 affords considerable discretion to boards of directors to impose appropriate limitations on the reimbursement requirements, consistent with their fiduciary duties and the equitable provisions of Delaware law. Section 213(a): Separation of Record Dates for Notice and Voting The amendments also revise Section 213(a) to allow a corporation's board of directors to set separate record dates for determining which stockholders are entitled to notice of a meeting (or an adjournment thereof) and which stockholders are entitled to vote at such meeting (or an adjournment thereof). In determining those stockholders entitled to vote, a corporation's board may set a voting record date that is later than the notice record date and on or before the meeting date.6 Section 213(a) is designed to address the concept of "empty voting," in which a person maintains voting power over shares but not an economic interest in the shares.7 While empty voting can, in theory, arise in a number of different circumstances, a concern is that empty voting can occur when, because of the length of time between the record date for a meeting and the date of the meeting, stockholders who have sold their shares, and therefore no longer have an economic interest in the shares, maintain voting power.8 By having two record dates—one for providing notice of the meeting and one for voting eligibility—corporations can better ensure that those who are voting at a stockholders' meeting have an economic interest in the corporation at the time of the stockholders' meeting. Section 145(f): Limiting Amendments to Indemnification and Advancement Rights The amendments add Section 145(f) to the DGCL, which provides that a right to indemnification or advancement of expenses under a provision of a certificate of incorporation or bylaw cannot be eliminated or impaired by an amendment of the provision after the occurrence of the act or omission to which indemnification or advancement of expenses relates, unless the provision contains, at the time of the act or omission, an explicit authorization of such elimination or limitation. This amendment overturns the effect of a 2008 Delaware Court of Chancery decision,9 which had held that indemnification and advancement rights could be amended or even eliminated so long as a claim had not been made against the indemnitee before the amendment was adopted. Section 225(c): Judicial Removal of Directors The amendments also add subsection (c) to Section 225, granting the Delaware Court of Chancery power to remove a director in the limited situation when, after either a felony conviction in connection with such director's duties to the corporation or a judgment on the merits that such director has breached his or her duty of loyalty to the corporation, the court determines that the director did not act in good faith and that removal is necessary to avoid irreparable harm to the corporation. An application for judicial removal of a director must be brought directly by or derivatively in the right of the corporation, and must be brought after the original proceedings finding the felony or breach of duty of loyalty. This section is designed to be very narrowly drawn, as historically only stockholders could remove directors, and there is a recognition that boards generally should not be able to remove another director merely because one director is not popular or dissents from the majority view. Rather, this section is designed to respond to situations that have occurred over the last few years, in which directors have been convicted of crimes but were unwilling to resign from the board and because of the fundamental principal that directors cannot remove other directors, the board was unable to take effective action. What You Should Do Now In light of the DGCL amendments discussed above, corporations should consider the following actions: - Carefully review the corporation's existing bylaws, in light of these changes as well as other recent developments in Delaware and federal law, to make sure that the bylaws are still appropriate. It is important to remember that the amendment of bylaws after a significant stockholder has indicated an intent to take action (or even just expressed dissatisfaction with the current plan, board, or management) may be reviewed with considerably closer scrutiny than amendments undertaken when there is no specific "threat," but rather for the purpose of bringing the corporation's bylaws into compliance with best practices and recent developments.
- Review on a holistic basis changes coming out of the SEC, the NYSE, Delaware, and elsewhere relating to the proxy process, and continue to monitor these changes in a meaningful fashion to determine how the corporation's bylaws should be changed or amended (if at all). This is becoming one of the most active proxy seasons in many years, both from a regulatory perspective as well as with respect to stockholder activism, and corporations, boards, and their advisers should continue to monitor these changes so that they are not surprised by events.
- Update bylaws as appropriate, effective August 1, 2009, to permit the use of dual record dates, and in connection with your next annual or special meeting after that date, consider whether ownership changes between the record date for notice of the meeting and the date of the meeting make it expedient to set dual record dates.
- Review certificates of incorporation and bylaws to determine whether indemnification and expense advancement provisions permit amendments after the occurrence of the act or omission to which indemnification or advancement of expenses relates.
This WSGR Alert was prepared by David J. Berger and Richard Cameron Blake, both of Wilson Sonsini Goodrich & Rosati's Palo Alto office. Wilson Sonsini Goodrich & Rosati will provide further information regarding the matters above as more information is made available. Please contact the authors listed above, your regular Wilson Sonsini Goodrich & Rosati contact, or any member of our corporate and securities practice or securities litigation department with any questions you may have about these matters and the potential implications they could have for your company.
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